Would the Obama administration’s plan for financial reform do what has to be done? Yes and no.It is a major blunder to not force the ratings agencies to be compensated by somebody other than the party requesting the rating. It is too obvious that the ratings agency will dance to the tune the piper is playing. This kind of corruption brought the system down. Obama is not fixing this. This is unacceptable.
Yes, the plan would plug some big holes in regulation. But as described, it wouldn’t end the skewed incentives that made the current crisis inevitable.
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President Obama’s speech outlining the financial plan described the underlying problem very well. Wall Street developed a “culture of irresponsibility,” the president said. Lenders didn’t hold on to their loans, but instead sold them off to be repackaged into securities, which in turn were sold to investors who didn’t understand what they were buying. “Meanwhile,” he said, “executive compensation — unmoored from long-term performance or even reality — rewarded recklessness rather than responsibility.”
Unfortunately, the plan as released doesn’t live up to the diagnosis.
True, the proposed new Consumer Financial Protection Agency would help control abusive lending. And the proposal that lenders be required to hold on to 5 percent of their loans, rather than selling everything off to be repackaged, would provide some incentive to lend responsibly.
But 5 percent isn’t enough to deter much risky lending, given the huge rewards to financial executives who book short-term profits. So what should be done about those rewards?
Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen.
Furthermore, the plan says very little of substance about reforming the rating agencies, whose willingness to give a seal of approval to dubious securities played an important role in creating the mess we’re in.
In short, Mr. Obama has a clear vision of what went wrong, but aside from regulating shadow banking — no small thing, to be sure — his plan basically punts on the question of how to keep it from happening all over again, pushing the hard decisions off to future regulators.
Friday, June 19, 2009
Krugman on Obama's Financial Regulation
Here are the key bits from Krugman's latest op-ed in the NY Times:
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I think most reasonable people have a foot in both camps on the issue of regulation. Like Goldilocks, we want neither too much nor too little.
The previous comment strikes me as too partisan. The claim Sarbanes Oxley is very expensive: including enormous direct ($80 Billion per year) and indirect costs to our economy and to innovation seems extreme. The US population is 307 million. A "cost" of $80 billion is over $250 per man, woman, and child. I can't imagine how a "reporting requirement" can cost that much. I doubt the paperwork costs that much.
So I looked through the references of the above commenter. Here is the relevant claim: "When Sarbanes Oxley was passed, the SEC (Securities and Exchange Commission) estimated the cost of compliance would be $91,000.00 per year for each public company. The most recent estimates for the cost of compliance are between $4.0 million and $5.0 million per year for publicly traded companies. The United States has over 18,000 public companies, which means the U.S. spends around $80 Billion a year to comply with Sarbanes Oxley."
The government says it costs $91,000 per company. That seems high. You can hire a very well qualified person full time for a year to do the "paperwork" for a company for this fee. I really doubt that a "reporting requirement" requires a person to spend 40 hours a week 52 weeks a year to file all the paperwork, so I think the SEC was cautious and even over-estimating the cost of compliance.
But Dale B. Halling, author of the two referenced items, claims that $91,000 is not the real cost, it is $4-5 million. Geesh! Get a grip. For $4 million you can hire 100 people working full time for a year to generate the "reporting" paperwork.
The claim of the above anonymous commenter doesn't pass the laugh test. The number is ridiculous.
So, where do we stand on regulation? The financial crisis shows that a failure to regulate can cost you 5% of GDP which in a $14 trillion economy is $700 billion, or about $2,300 per person. So obviously too little regulation is expensive.
Too much regulation will cost you -- I'm guessing here -- about $300 billion a year, or $1,000 per person.
Neither alternative is something a reasonable person would want.
The solution is the Goldilocks solution: get the right amount of regulation. Not too much. Not too little.
In the real world, we will never all agree on the exact right "Goldilocks amount". So we have to compromise. We just went through 30 years of too little regulation. I say we give the politicians 20 years of maybe a little too much (so long as they don't overdo it).
Nobody knows exactly what the right amount is, but clearly too little doesn't work, and too much will threaten us as the anonymous commenter points out. But in today's environment, I think a reasonable person would say we need a bit more.
Obama has laid out some new regulations. They will help. But it is pretty clear, as Krugman points out, that they didn't go far enough. Why not?
As DeepThroat said in the Watergate Affair "follow the money". Lobbyists for corporate America are buying politicians to reduce the "heavy hand" of regulation. The public needs to keep the pressure up on the politicians to counter this influence to make sure we stiffen the politicians spine so that we can get somewhere near to the Goldilock's solution.
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